To the Krugmans and DeLongs of the world, it is intuitively obvious that with unemployment approaching 10 percent we cannot possibly have inflation, so monetary and fiscal policy should be set on full speed ahead. However, if a post-bubble economy were to behave more like a supply shock than a demand shock, we could be in for a rude awakening. The monetary and fiscal expansion may have little or no effect on unemployment, and after a bit of a lag we could see inflation come back with a vengeance. That is why I am not convinced that Sumnerian monetary expansion last year would have worked any wonders.

Sumnerian monetary expansion last year would not have returned the economy to full employment, but it may have prevented nominal spending from contracting at its sharpest rate in the post-WWII era. The decline in nominal spending is staggering as can be seen here (or in my annotated form here). Given nominal rigidities, such a collapse in aggregate demand only served to exacerbate the "recalculation" going on in the real economy. I know we disagree on this point, but I believe the Fed does have a lot of influence on current nominal spending. Consequently, it could have done a lot more.

I see no reason why a "recalculation" must necessarily lead to a severe recession. I do see, however, how massive market failure (i.e. aggregate demand externalities) could turn a regular recession into a great recession. In my view, this is exactly what happened from 1929-1933 and in late 2008, early 2009.

If you're right, Arnold you can make a bundle in the TIPS market. Will you go for it?

Your confidence in the truthfulness of government statistics is not widely shared. If right, Arnold could make a killing in the gold market, but to make a killing in the TIPS market, the government would have to admit him to be right

Bryan Caplan: "If you're right, Arnold you can make a bundle in the TIPS market. Will you go for it?"

That's a typical mistake made by people who don't understand markets. It would be easy to be right on the direction of the TIPS market and be wrong on the timing and the levels.

But even if you were right on the direction and timing, how much could you reasonbly make? Could you double your money (100% return)? If you invested $10,000, you would make $10,000 additional dollars. Is that a bundle? How about turning $100,000 into a million (1,000% return)? That's more like it, but in order to do that you would have to be highly leveraged and get the exact timing perfect. In order to make a bundle, you will have to invest a bundle first.

Not that Kling needs defending, but he wasn't trying to predict the exact timing of inflation or the exact level. He was doing what any good economist should do--make a qualitative forecast of the direction of the market, knowing that perfect forecasts of levels and timing are impossible. Because smart people know that perfect forecasts are impossible but qualitative forecasts are necessary and good, they will invest in their forecast but with approprieate hedges. However, the hedges make it impossible to earn a bundle. Some people do it, but as the black swan should remind us, they're just lucky. People also earn a bundle in Lost Wages, NV and in lotteries, but no one calls that investing.

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